CENTRAL BANKSPratiksha

MEANING & DEFINITION OF CENTRAL BANK In every country there is one bank which

acts as the leader of the money market, supervising, controlling and regulating the activities of commercial banks and other financial institutions.

According to the statutes of Bank of International Settlements, “the bank of the country to which has been entrusted the duty of regulating the volume of currency and credit in that country”

OBJECTIVES OF CENTRAL BANK

Objectives of Central Bank

Maintain internal value of currency

Preserve the external value of currency

Promote financial

institutions

Promote economic

growthEnsure price

stability

FUNCTIONS OF CENTRAL BANK Monopoly of Note Issue Custodian of Foreign Exchange Reserve Banker to the Government

Public Debt functionsAdvisor to the Govt on economic reforms

Banker to the Banks Controller of Credit Promoter of Economic Development

BANKER TO THE COMMERCIAL BANKS

Custodian of cash reserves

Lender of last resort

Clearing agent

CREDIT CONTROL

It means the regulation of the creation and contraction of credit in the economy.

Objectives of Credit controlStability of Internal Price-levelChecking Booms and DepressionsPromotion of Economic DevelopmentStability of the Money MarketStability in Exchange Rates

METHODS OF CREDIT CONTROL Quantitative controls are designed to

regulate the volume of credit created by the banking system. These measures work through influencing the demand and supply of credit.

Qualititative measures, on the other hand, are designed to regulate the flow of credit in specific uses.

Quantitative Methods

Qualitative or Selective Methods

Bank Rate Policy Issue of directives

Variation in Reserve ratios

Restriction of purpose

Open market Operations

Margin requirements

Credit rationing

Rate of interest

Moral persuasion

QUANTITATIVE METHODS- BANK RATE

Bank rate refers to the official minimum lending rate of interest of the central bank.

It is the rate at which the central bank advances loans to the commercial banks by rediscounting the approved first class bills of exchange of the banks.

Hence, bank rate is also called as the discount rate.

QUANTITATIVE METHODS- BANK RATE Theory of Bank Rate- affects the supply of

credit.

Working of Bank Rate Inflationary scenarioDeflationary scenario

The Process of Bank Rate Influence

Limitations for Bank Rate

QUANTITATIVE METHODS- OPM

Open market operations refer to the purchase and sale of securities by the central bank.

In its broader sense, the term includes the purchase and sale of both government and private securities.

But, in its narrow connotation, open market operations embrace the purchase and sale of government securities only

QUANTITATIVE METHODS- OPM Theory of Open Market Operations

Objectives of Open Market OperationsTo eliminate the effects of exports and

imports to gold under the gold standard.To impose a check on the export of capital.To remove the shortage of money in the

money market.To make bank rate more effective.To prevent a ‘run on the bank’.

QUANTITATIVE METHODS- OPM Conditions for OPM

Institutional FrameworkLegal FrameworkMaintenance of a Definite Cash

Reserve RatioNon-operation of Extraneous FactorsNon-existence of Direct Access of

Commercial Banks to the Central Bank

Limitations for OPM

QUANTITATIVE METHODS- VRR Variable Reserve Ratio refers to the

percentage of the deposits of the commercial banks to be maintained with the central bank, being subject to variations by the central bank.

In other words, altering the reserve requirements of the commercial banks is called variable reserve ratio.

QUANTITATIVE METHODS- VRR Theory of VRR

The theory underlying the mechanism of variable reserve ratio is that by varying the reserve requirements of the banks, the central bank is in a position to influence the size of credit multiplier of the banks and therefore the supply of credit in the economy.

Working of Variable Reserve Ratio

Limitations of VRR

SELECTIVE OR QUALITATIVE METHODS

Features of Selective Measures

Objectives

o Distinguish between essential and non-essential uses of bank credit.

Only non-essential uses are brought under the scope of central bank controls.

Affect not only the lenders but also the borrowers.

Divert the flow of credit Regulate a particular sector of

the economy Regulate the supply of

consumer credit. Stabilise the prices of inflation

sensitive goods. Stabilise the value of

securities. Correct an unfavourable BoP Bring under the control of the

central bank Exercise control upon the

lending operations of the commercial banks.

MEASURES OF SELECTIVE CREDIT CONTROL

Margin Requirements Regulation of Consumer Credit

They limited the amount of credit that might be granted for the purchase of any article listed in the regulations; and

They limited the time that might be agreed upon for repaying the obligation

Rationing of Credit Fixes a limit upon its rediscounting facilities for

any particular bank. Fixes the quota of every affiliated bank for

financial accommodation from the central bank.

MEASURES OF SELECTIVE CREDIT CONTROL

Control through DirectivesWith direct power of controlling bank

advances either by statute or by mutual consent between the central bank and commercial banks.

Moral Suasion

Direct Action

Publicity

LIMITATIONS The selective controls embrace the commercial banks

only and hence the nonbanking financial institutions are not covered by these controls.

It is very difficult to control the ultimate use of credit by the borrowers.

It is rather difficult to draw a line of distinction between the productive and unproductive uses of credit.

It is quite possible that the banks themselves through manipulations advance loans for unproductive purposes.

Selective controls do not have much scope under a system of unit banking.

Development of alternative methods of business financing has reduced the importance of selective controls.

WEAPONS OF CREDIT CONTROL BY RBI

Quantitative or general methods or instruments. Bank rate Open Market Operations Cash Reserve Ratio (CRR) Statutory Liquidity Ratio (SLR)

Qualitative or selective methods or instruments. Variation of Margin Requirements Credit Authorization Scheme (CAS) & Credit

Monitoring Arrangement (CAM) Control of Bank Advances Differential Interest Rates Credit Squeeze Policy Moral suasion

RBI & MONETARY POLICY The main objective of monetary policy pursued

by the Reserve Bank of India is that of ‘controlled monetary expansion.’

Objectives of Monetary policy are:Expansion in the supply of money, and

As incomes grow the demand for money as one of the components of savings tends to increase.

Increase in money supply is also necessitated by gradual reduction of non-monetised sector of the economy.

Restraint on the secondary expansion of credit. While exercising restraints, care should be taken

that the legitimate requirements of agriculture, industry and trade are not adversely affected

COVERAGE OF MONETARY POLICY

RBI AND ECONOMIC DEVELOPMENT

ASSIGNMENT QUESTIONS Recent changes in the Monetary Policy

of RBI past 3 months.

Impact of the RBI’s monetary policy on the economy

Impact of the Monetary policy on the performance of the Banks